October 16, 2002
In a philosophy class a lifetime ago I was told that how
people described the future indicated a great deal about how they will act in
the present. If the future is
described as amazing, holding opportunities, and offering promise, then
consumers will spend and investors will take on risk.
If, by contrast, the future is described as continuous
conflict, struggles, and fearful; then people become more protective and
preserving in the present. The
flight from stocks to treasury bonds in recent weeks strongly suggests that fear
rather than hope is dominating our outlooks.
Of course, fear could be justified and protection could be
appropriate. However, fear can also
create conditions that might not occur if more optimism was present.
One of the great quotes that we learn in school about the Great
Depression is that "all we have to fear is fear itself."
Should we be fearful economically at this time?
It certainly would help if we were debating economic
policies that addressed those fears or received explanations for why prevailing
policies will or are working. Treasury
secretary O'Neill has argued that the economy is basically sound (i.e. policies
are working) but every consecutive week that stock values fall increases
questions about the appropriateness of that position.
The President, in arguing that his tax cuts should be made
permanent, tacitly admits that his original proposals for phased in cuts were
not appropriate. We continue to
wait for any results from his summer economic summit, which also suggests that
not everything is right with the economy.
Alan Greenspan, chairman of the Federal Reserve, admits
that weakness rather than strength is more likely in the next few months; but he
makes no changes in policy to address this prospect.
With so little direction from policy makers (including the
Democratic opposition, who provide very few policy initiatives of their own), I
should like to address whether policies are needed and what they are.
Secretary O'Neill is not too far off-base in his
assessments. The inventory excesses
have been eliminated. Undesirable
capital spending, especially in telecommunications and internet infrastructure,
have been halted. Job losses have
created some excesses in office and apartment construction, but the markets
already are responding to these problems by reducing activity.
Although there remains a danger that lost paychecks will
lead to reduced consumer spending, the workweek for those with jobs has been
expanding. As a result, inflation
adjusted purchasing power continues to expand about 2 percent per year.
Inflation itself has been subdued except in a few pockets
of health and education and in some commodities, such as energy.
Even with rising gasoline prices, consumers have more jingle in their
pockets than a year ago.
Unfortunately, tax cuts that would further support consumer
spending either were distributed last year or must await 2004 for more
reductions. Instead of worrying
about whether his tax cuts are permanent, the President should be arguing for
advancing the 2004 cuts to January of 2003, when they would be very welcome
Of course, what happens with Iraq remains a major
uncertainty. How much would a war
cost? What would be resolved by it?
How many resources must be diverted to the Middle East to ensure that a
regime change is more than a change in the tyrant's face?
How many body bags will be needed? There
are no pleasant thoughts in any of these prospects.
Although all conflicts can lead to economic surprises, the
magnitude of our costs appear to be manageable.
The uncertainties are creating more economic hardship than
even worst case projections suggest will be created by a conflict.
Virtually every retailer is lowering sales estimates for Christmas.
Though the West Coast labor strife is also mentioned, Iraq is what they
believe is most worrisome to their customers.
The other concern is that consumer spending is too large
relative to the net worth of households. A
plunging stock market merely intensifies that worry.
As I mentioned in the past, consumers will spend as long as the cost of
servicing their debt does not rise relative to their income.
To insure consumer involvement, I would push for even lower
interest rates in the short run. Only
after corporate credit worthiness begins to improve and corporate spending
rebounds would I worry about increasing interest rates.
After all, any rate increases will begin to undermine consumer ability to
service their debt.
I would allow full write-off of investment losses against
current incomes for investors. Capital
gains would be eliminated, but the investment costs against which investment
income is compared would be increased by the rate of inflation from the point of
acquisition of the investment.
At least, those are the proposals I would make. And then I would remind Americans that our economic system is sound, our banks have lending capacity, and all we need is a better belief in our future.